By Jeffrey May, J.D.
The federal district court in Chicago erred in denying the FTC’s request for a preliminary injunction blocking the proposed merger of Advocate Health Care Network and NorthShore University HealthSystem—two of the leading providers of general acute care inpatient hospital services in Chicago’s northern suburbs. Significantly, the district court misunderstood the hypothetical monopolist test, which the FTC and State of Illinois used to identify a relevant geographic market where anticompetitive effects of the merger would be felt, according to the U.S. Court of Appeals in Chicago. Thus, the appellate court reversed the district court’s June 2016 decision and remanded for further proceedings. The merger was to remain enjoined pending the district court’s reconsideration of the preliminary injunction motion (FTC v. Advocate Health Care Network, October 31, 2016, Hamilton, D.).
This is the second appellate court victory for the FTC in a hospital merger challenge in recent weeks. In late September, the U.S. Court of Appeals in Philadelphia reversed a lower court’s finding that the FTC too narrowly defined the geographic market in its challenge to the proposed merger between Penn State Hershey Medical Center and Pinnacle Health System in central Pennsylvania. In that case, the lower court was directed to enter the preliminary injunction. The parties have since dropped the deal.
In the Chicago-area hospital merger challenge, the FTC filed an administrative complaint and a court action seeking a preliminary injunction in December 2015, following a 15-month investigation of the combination of Advocate and NorthShore. The transaction is valued at approximately $2.2 billion.
Relevant market. The parties agreed that the product market was a cluster of inpatient general acute care services—specifically, those services sold to commercial health plans and their members, such as abdominal surgeries, childbirth, treatment of serious infections, and some emergency care. The dispute arose over the relevant geographic market, which the government asserted was limited to Chicago's "North Shore Area."
The appellate court identified three notable features of geographic markets for hospitals. First, there are often only a few hospitals in a geographic market because most patients prefer to go to nearby hospitals. Second, patients vary in their hospital preferences and willingness to travel for care. Third, consumers do not directly pay the full cost of hospital care and are usually not sensitive to retail hospital prices, while insurers respond to both prices and patient preferences.
Hypothetical monopolist test. To define the market, the FTC employed a hypothetical monopolist test, which focuses on “the area of effective competition” between firms. The test asks what would happen if a single firm became the sole seller in a proposed region. If such a firm could profitably raise prices above competitive levels, that region is a relevant geographic market.
The FTC’s market consisted of 11 hospitals, which included the six party hospitals and five other nearby hospitals. The FTC’s expert determined that this market passed the hypothetical monopolist test. The expert excluded academic medical centers from the candidate market. Moreover, the market included only hospitals that drew from both Advocate’s and NorthShore’s service areas.
The appellate court took issue with the district court's suggestion that the FTC expert’s analysis was circular. The appellate court explained that the hypothetical monopolist test used an iterative process, first proposing a region and then using available data to test the likely results of a price increase in that region. “The district court seems to have mistaken those iterations for circularity,” the appellate court said.
Exclusion of academic medical centers. The appellate court also rejected the lower court’s conclusion that there was no “economic basis” for the exclusion of academic medical centers from the market. Demand for those few hospitals differed from demand for general acute care hospitals like these parties’ hospitals, which draw patients from much smaller geographic areas.
“Silent majority fallacy.” Lastly, the appellate court considered the so-called “silent majority fallacy,” which explains anticompetitive price increases resulting from the unwillingness of a “silent majority” of patients to travel for care. The district court apparently discounted the testimony of insurers that an insurer’s network must include either Advocate or NorthShore to offer a product marketable to employers. According to the appellate court, the district court erred in assuming that diversion ratios— indicating which hospitals patients consider substitutes if there primary choices were not available—translated neatly into options for insurers.
“Insurers are the most relevant buyers,” the appellate court pointed out. “Insurers must consider both whether employers would offer their plans and whether employees would sign up for them.”
The appellate court said in closing: “The geographic market question asks in essence, how many hospitals can insurers convince most customers to drive past to save a few percent on their health insurance premiums? We should not be surprised if that number is very small. Plaintiffs have made a strong case that it is.”
The case is No. 16-2492.
Attorneys: Jamie E. France for the Federal Trade Commission. Robert W. Pratt, Office of the Illinois Attorney General, for State of Illinois. Daniel J. Delaney (Drinker Biddle & Reath, LLP) and Kimberly Dawn Rancour (Hogan Lovells US, LLP) for Advocate Health Care Network and Advocate Health and Hospitals Corp. Linda T. Coberly (Winston & Strawn, LLP) for Northshore University Healthsystem.
Companies: Advocate Health Care Network; Advocate Health and Hospitals Corp.; Northshore University Healthsystem
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